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Schwab refusing to pay off clients in 'auction-rate' issues

July 20, 2009 | 7:08
pm

Instead of the carrot-and-stick approach, New York Atty. Gen. Andrew Cuomo on Monday used two sticks in his campaign to force Charles Schwab Corp. to pay off clients in those notorious auction-rate preferred securities.

For stick No. 1, Cuomo threatened Schwab with a lawsuit if the discount brokerage fails to agree to buy back the offending securities.

They were pitched by brokers to yield-hungry small investors as safe and easily redeemable -- which they were, until demand for all such engineered securities dried up. That left investors stranded in about $330 billion of auction-rate issues, unable to sell (although still earning interest).

Cuomo, the SEC and other securities regulators have since negotiated buy-back settlements with 20 brokerages and other financial firms that were selling auction-rate preferred debt, including Goldman Sachs, Merrill Lynch and Deutsche Bank.

To compel settlements, regulators have asserted that the brokerages misrepresented the safety of the securities.

In a letter to Schwab warning of a lawsuit, Cuomo excerpted from interviews his office did with Schwab brokers as part of his probe and from audio recordings of Schwab sales pitches. One broker allegedly told a client that getting into the securities "is the tough part. Getting out of it is easy as just selling."

In its rebuttal, Schwab said that its brokers, "while trained to levels beyond industry standards, could not be expected to foresee and disclose market risks that even regulators and market experts did not foresee."

Schwab asserts that the big brokerages that created the securities should have been forced to buy them back from all investors who purchased them, including investors who bought the issues from third parties such as Schwab.